The IRS sent a notice, 2016-66, which requires filings by entities which meet specific requirements. These entities may include dealer- or producer-owned reinsurance companies, as well as the dealership itself and the owners of the dealership.
Originally, the filings were due by Jan. 30, 2017 but the IRS extended the deadline to May 1, 2017. Let’s take a moment to answer some frequently asked questions about Notice 2016-66.
1. Why Is the IRS Making Me File This?
For decades, dealers have owned reinsurance companies which have reinsured some or all of the risk on the F&I products they sell, including vehicle service contracts, GAP and other products. Most of these companies use the 831(b) election for their reinsurance company (which changes the taxation).
In 2015, Congress passed legislation which increased the limits of the 831(b) election from $1.2 million to $2.2 million (for 2017 and indexed for future years) in premium each year. In addition to this, there were other provisions related to 831(b) companies, including authorizing the IRS to require this disclosure.
Over the past few years, other companies have started insurance companies using the 831(b) election. Typically, in these cases, the companies are insuring their own exposures such as loss of key contracts, litigation risk and cyber risk (among others).
The IRS is concerned that some of these transactions may be abusive. While there are several cases in litigation, it has not generally been found by the courts at this time that companies insuring their own risk in this way is abusive.
While the IRS does not appear to be focusing on dealer-owned reinsurance companies, these companies are utilizing the same portion of the tax code and may fall under the provisions of the notice.
2. Do All Dealer-Owned Reinsurance Companies Need to File?
Our interpretation is that companies that have the following conditions will need to file the 2016-66:
- “Dealer Obligor” business (further discussed below), and
- Common ownership between the reinsurance company and the dealership, and
- Loss ratios (the ratio of losses to premium) under 70% for the covered period or loans by the reinsurer to related parties.
Dealer obligor business are contracts for which the dealer would be legally required to pay a claim in the absence of a contract. One example is GAP waiver contracts, where the dealer agrees to pay the balance of a loan under certain conditions; namely, the vehicle being declared a total loss by an auto insurance company).
Of course, the dealer is really never under obligation to pay the loan, since these types of contracts are always insured. But, technically, the risk is passed from the consumer to the dealer and then to the insurance company and then back to the dealer in the form of reinsurance.
Another example is limited warranty contracts. These contracts are typically marketed and placed on every vehicle sold by the dealership (or a significant segment like all new vehicles). The customer does not “opt in” to the transaction. The dealer is simply warranting the product to the customer under certain conditions.
Once again, the risk passes from the customer to the dealer and then to the insurance company and finally back to the dealer again through the reinsurance company. In this case, the insurance product may not even be required — if you sell a car, you can warrant it however you wish — but these types of warranties are typically insured.
If your reinsurance company has engaged in these types of transactions, we feel that it would be wise file the 2016-66.
3. What About Dealerships and Dealership Owners?
If the reinsurance company and the dealership have 20% or more common ownership, the dealership and all dealership owners must make a separate disclosure. A participant (including reinsurance companies, dealerships and dealership owners) who fails to make the required disclosure may be subject to a penalty of up to $50,000.
The 2016-66 notice has caused some concern and confusion among the F&I community. We feel that the concern is not warranted as the accounting and tax positions for dealer owned reinsurance companies have been established for a number of years. The confusion is real because interpreting an IRS notice with no precedent is always difficult. We feel that it is better to be safe than sorry and make a protective disclosure if you might meet the conditions of the notice.
Of course, you should engage your own professionals for legal and accounting advice as it relates to this notice. Nothing in this article constitutes legal, accounting or tax advice, or a representation that any position is suitable or appropriate to your situation.